Livermore: Challenge of Speculation

Jesse Livermore

“THE game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the man of inferior emotional balance, or for the get-rich-quick adventurer. They will die poor.” – Livermore

Famous trader Jesse Livermore began his book, How To Trade in Stocks, with a general overview of the concepts and strategies that he followed. This book, like many of the great trading classics, is just as relevant now as it was when it was written in 1940. Livermore would argue that this is because the market never really changes because it is based on the human emotions of fear and greed.

No Substitute For Hard Work

“The fruits of your success ail be in direct ratio to the honesty and sincerity of your own effort in keeping your own records, doing your own thinking, and reaching your own conclusions.” – Livermore

The first point that Livermore makes right from the beginning is that in order to be successful in any form of speculation, you must be willing to put in the time and effort. He famously draws a comparison that someone asking him for a stock tip is like someone asking a surgeon or an attorney how to make some quick money in their profession.

Becoming a profitable speculator will take years of studying the markets. You have to be willing to put in the time to learn what works and what not to do. One aspect of this studying will involve keeping records of your trades as well as your thought process about them. All of the great traders agree that one of the best ways to improve your trading is to dissect your past trades and learn from your mistakes.

Livermore stresses that you must keep your own records and not let someone else do it for you. He argues that this helps your ability to think for yourself and develop your own opinions.

He also is adamant that in order to be successful, you must treat your trading like a business. Anyone who looks at trading as gambling or “playing the market” is doomed to failure before they even begin.

Respect The Market

“There are times when one should speculate, and just as surely there are times when one should not speculate.” – Livermore

Livermore continues by describing the importance of respecting the markets in which you decide to speculate. He tells us that in every market, there are times when it is appealing to get involved and there are times when we should stay on the sidelines. He says that it is impossible to make money every day or every week and that we must be more selective and pick our spots.

This is because the markets are comprised of people, who trade based on emotion. This is the reason that the markets often behave irrationally. People in general, and specifically in crowds, tend to feel the emotions of FEAR and HOPE at the exact opposite times from when they should. This is the root cause of bubble rallies and panic crashes.

In this section, Livermore also notes that a successful speculator will wait for the market to show him confirmation of an anticipated move before taking a position. Missing the very first part of a move in the speculator’s insurance policy against being dead wrong. The same can be said for market tops. Successful speculators make their money from the middle part of major moves.

He also tells us that successful speculators have no business arguing with the market. If the market does not confirm your opinion on where that market should go, then it is your opinion that needs to change, not the market.

Involuntary Investors

“Investors often take tremendous losses for no other reason than that their stocks are bought and paid for.” – Livermore

Livermore also addresses the tendency of speculators to let their losing positions become long term investments. This is simply a matter of not being able to admit that the market is right and your opinion is wrong. Many investors have lost fortunes by not taking the first, small loss.

Livermore notes four railroad companies that were considered safer than a savings account, all of which eventually fell to less than a dollar per share. Keep in mind that this was written in 1940, long before the collapses of the Dot Com stocks in 2001 or the Financial stocks in 2008.

The general concept here is that you should never allow yourself to ride a loser all the way down to nothing. You need to be able to recognize that a stock is in a downward trend and be able to get yourself out. You can always get back in once the trend changes.

Quick Pointers

Livermore closes this chapter with four quick bullet point ideas that a speculator should keep in his mind at all times:

“One should never sell a stock, because it seems high-priced.” – Livermore

“Conversely, never buy a stock because it has had a big decline from its previous high.” – Livermore

“It is foolhardy to make a second trade, if your first trade shows you a loss.” – Livermore

“Never average losses.” – Livermore